March 10, 1976
According to directors of the First District, the business situation in New England shows no significant change from last month. Retail sales have remained strong, and the outlook for retailing is very encouraging. On the other hand, capital goods industries and construction have yet to experience a convincing recovery. Bankers report that loan demand is weak, and, that they have discounted the possibility of a marked increase in lending activity this spring. The directors note that financial markets have become extremely sensitive to the tone of monetary policy.
New England machine tool firms are beginning to lay off personnel. Order backlogs had been sufficient to maintain production schedules until recently. It had been hoped that new orders of smaller tools would have improved by now, since they tend to lead investment recoveries. However, orders have been disappointing and show no signs of improvement, so that lower production schedules are warranted. The new orders for bearings, construction equipment, and super-alloy metals also continued weak.
The directors speculate that capital spending will continue cautiously, reasoning that businessmen are still concerned with strengthening balance sheets, especially since the outlook is so unsettled. Our economic crises are so far from being solved and the future tone of credit markets is so uncertain that firms are less willing to lever current capital needs, much less those needs projected for coming years.
Construction activity is also weak. There is little interest in nonresidential construction, since existing structures exceed present requirements. Similarly, before condominium and apartment construction may revive, the existing stock must be sold at reasonable prices. Single-family-home sales have recovered modestly, but the large stock of homes to be sold plus soft prices inhibit building activity at this time. Directors note that the price of new housing has outstripped family incomes.
Mortgage interest rates have fallen sharply in some areas of New England, while remaining fairly steady in others. One director reports that some Connecticut thrift institutions in their areas have been expanding by attracting checking and NOW accounts, and the full cost of these liabilities is only now becoming evident to the thrift institutions.
Bankers continue to report that loan demand is weak and that some modest competition for customers by out-of-state banks is evident. However, there are no substantial discounts on the effective cost of funds to borrowers. One director comments that small bankers in New England are caught between holding companies and thrift institutions. Larger business customers need the services that larger banking organization offer, while thrift institutions offer consumers better savings rates. This director looks favorably on an equalization of savings-yield ceilings, and he forecasts a proliferation of multibank holding companies.
Professors Eckstein, Houthakker, and Tobin were available for comment this month. Eckstein noted that the economic expansion is rolling along the forecasted track and that there is no need to revise upward the 6 percent real growth figure. On the basis of recent wholesale price and productivity data, Houthakker has revised his price projections upward to 5 to 5 1/2 percent during 1976. He pointed out that declines in the unemployment rate are partly the other side of the coin of weak increases in productivity which, in turn, reflect weak output gains and put upward pressure on prices.
Houthakker does not feel there is yet sufficient evidence of a shift in money demand. He notes that this relationship is only moderately stable, particularly in the short run. He worries that the historical relationships still hold, so that the recent rate of money growth will not support anything like a 6 percent rate of real growth. According to Eckstein, DRI studies indicate that portfolio experience and the mix of the economic advance are statistically significant arguments in the money demand function. With these variables included, recent errors have been small. This new formulation does imply that the Federal Reserve System must either redo its money target exercise or disengage from the aggregates and look at a broader picture of financial variables. Updating the Goldfeld money demand equations, Tobin found large errors recently both in Ml and in time deposits. Tobin's explanation of these large errors centers on the substantial decline in commercial and industrial loans, which before last year had exhibited a strong upward trend. Reduced borrowing implies lower deposits through a compensating balance mechanism. The decline is also due to caution on the part of the banking system. Borrowing has been discouraged by a prime rate which is high relative to open market rates, such as the commercial paper rate.
Tobin feels that the rise in the Federal funds rate was unneeded. It is inappropriate for stimulating advances in housing, business fixed investment, and state and local government capital spending which must take over when consumer spending and inventory accumulation give out. Houthakker also favors a significant reduction in the Federal funds rate. Eckstein believes that short-term rates should not rise significantly right away. Specifically, the Federal funds rate should average about 5.3 percent in the second quarter.